Cocoa: Deficits for the foreseeable future

Our July 30 recommendation to establish a long position in cocoa (NYBOT:CCZ13) would have been a dandy – had we not suggested to patiently wait “...for setbacks.” Unfortunately, there were no setbacks. The market took off within days and has since rallied by more than $400 per tonne, or 18%.

There have not been any earthshattering changes in the fundamentals, but the developments on both the supply and demand sides continue to be bullish.

About 65% of global supply of cocoa beans is grown in the Ivory Coast and Ghana, and production levels have not increased over the past few years. While some minor producing nations have increased output, others have seen declines. Brazil, for example, had a bit of a renaissance in 2012-13 after years of falling off the cocoa map, but for 2013-14, arrivals are down 40%, year-over-year. Overall, global production is stagnant.

Aside from intermittent weather problems, crops in both the Ivory Coast and Ghana have suffered from insufficient application of fertilizer and from neglect of other crop enhancement activity.

The Ghanaian government successfully engineered a doubling of the country’s crop size over the past 10 years, by subsidizing 50% of fertilizer costs. Last month, however, the government announced that it will be phasing out the subsidies in the coming years. Fertilizer purchases have reportedly plunged. So it is highly unlikely to see any further output growth.

With the jump in world prices, the Ivorian cocoa ministry recently raised the minimum prices farmers will receive for their beans. But poor pesticide and fertilizer usage is widespread, and the increase in farmers’ income will not readily find its way to improved crop management.

Global demand, at the same time, has been quite strong. Third-quarter European grind figures, released on Oct. 10, show a 4.7% increase over last year. When compared with anemic production, it is not difficult to see why the market has tightened.